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The Real Challenge for China’s Third Plenum

by Elizabeth C. Economy
November 8, 2013

A security guard stands at the Great Hall of the People in Beijing on November 7, 2013 (Kim Kyung-hoon/Courtesy Reuters). A security guard stands at the Great Hall of the People in Beijing on November 7, 2013 (Kim Kyung-hoon/Courtesy Reuters).

A version of this post originally appeared in the Economic Times and can be found here.

Anticipation is high as China approaches the third plenum of the 18th Party Congress, scheduled to take place on November 9-12. Why the excitement?

When the second largest and fastest-growing economy in the world decides to lay out its plan for economic reform over the next decade, people are bound to pay attention. Phrases such as “mega reform plan” are used liberally by analysts outside China to describe what they believe is likely to emerge from the meeting. The Chinese government even has a website to help meet the demand for early insight into what might be in store.

Certainly, the Chinese economy needs “mega reform.” For over a decade, the Chinese leadership has sought to make progress in three fundamental areas: transforming the country from a manufacturing to an innovation nation; moving away from an investment- and export-led economy to a consumption-based one; and reducing the role of vested interests (state-owned enterprises) in the economy.

Old Habits Die Hard

Progress on such reforms, however, has been elusive, and these broad shifts in the economy require a number of secondary reforms to succeed. These include liberalising the financial system, reforming the politically sensitive Hukou (residency permit) regulations that divide urban and rural residents, and undertaking new investments in social security, health care, and education.

Merely announcing new policies will not be enough. China’s political economy is littered with failed policy initiatives, such as bold efforts to establish a green GDP, to rein in non-performing loans, and to attract overseas talent through the global “1000 Plan” program. Passing regulations and adopting policies is only one small part of the reform battle; the real challenge is ensuring that government agencies and local governments implement the initiatives that are announced. This means having in place the right policy environment to support the initiatives. For example, Beijing’s effort to make its economy a center of global innovation by attracting the best and brightest back to China through its talent program has suffered because Chinese universities lack the freedom of intellectual inquiry, debate, and transparency that Chinese overseas scholars have grown accustomed to. In addition, the poor state of China’s environment, health care, and educational system is a significant disincentive to many potential returnees. Despite attractive financial packages, as well as an array of other benefits, many of the most talented Chinese continue to believe that the best opportunities for innovative work remain outside the country. Therefore, if China’s effort to transform itself into an innovative economy is to succeed, Beijing must reform broader social and political institutions as well.

China’s new leaders will also face significant political opposition to real economic reform. Changing the fundamentals of the Chinese economy will be painful. The potential losers in a “mega reform plan”—state-owned enterprises, the large banks, and local officials, in particular—will fight hard to maintain their dominant roles in the Chinese economic hierarchy.

And there will be hiccups along the way. This past June, for example, Beijing attempted to rein in bank lending and watched as interbank borrowing rates skyrocketed overnight. As concerns over the potential of the credit crunch to turn into a crisis mounted, however, the People’s Bank of China rode to the rescue, providing liquidity through the injection of new funds. Living through the pain of economic reform will not be easy, but the challenge will only increase over time.

The third plenum will almost certainly announce a broad range of initiatives to ensure sustained economic growth. The real issue is not what is announced at the plenum, but whether the government develops a policy environment in which these reforms can flourish. If that happens, then we really should be excited; but that will require waiting a few years, not a few days.

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